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A strategy for the UK’s future trade policy

Submitted by on 30 Sep 2016 – 17:05

The United Kingdom’s future trade policy should certainly start with the EU, its main and most proximal trade partner, writes Mark Manger, a Professor at the University of Toronto and a former consultant to the Governments of Canada and Japan on Free Trade Agreements. Clarifying the intricacies of forming trade agreements with other countries, he notes that retaining the existing European templates of trade for drafting FTAs with other countries would barely cost a thing

Following the vote to Leave the EU, the new British government faces the task of meeting the expectations of an unlikely coalition of voters: from farmers who currently receive EU subsidies and citizens in economically deprived areas worried about immigration to those who hope to light a ‘bonfire of EU regulations.’ The appointments to the new British cabinet suggest that the proponents of free trade and radical deregulation have won the day. The declared aim is to negotiate trade agreements with growing markets in Asia, the Commonwealth, and most importantly the US. At the same time, recent polls confirm that Britons expect net immigration to considerably fall in the aftermath of UK’s exit vote.

Notwithstanding statements by disappointed Remain campaigners, many of these objectives can be met: Britain should negotiate a free trade agreement according to Article 24 of the General Agreement on Tariffs and Trade (GATT) and Article 5 of the General Agreement on Trade in Services (GATS) with the EU. In effect, this means that Britain should leave the EU’s customs union as part of the withdrawal agreement, and immediately start negotiating a free trade agreement with the EU. Meanwhile, it is in Britain’s best interest to focus on its trade relations with the EU first, and leave other Free Trade Agreements (FTA) for later. To be sure, such an agreement would never be as economically beneficial as remaining within Europe’s single market. But it is a coherent reading of the referendum outcome that a majority of British voters would trade off some economic wealth for limits on immigration from the EU.

The freedom to negotiate individual trade agreements with other countries comes at a price: An FTA requires rules for what duties to charge on goods that are made of inputs from different places. These ‘rules of origin’ are among the most complex topics in trade negotiations. They determine whether a good qualifies for tariff-free shipping between members, if it uses inputs from outside the common FTA. In a world of complex supply chains, the rules quickly become complicated, and sometimes make up 2/3rd or more of the text of an FTA. Any such agreement would require British exporters to document that they comply with these rules. All of this quickly adds to the cost of trading.

At the same time, there is much common ground between the UK and the EU. No matter the nostalgia for when the UK traded mainly with its former colonies, empirical research has established beyond doubt that economic size and geographic proximity are the best predictors of how much two entities will trade with each other. Also, given the high level of existing integration, British products use many European inputs already, even when the finished goods are exported elsewhere. Britain would not lose anything by following the existing European templates for rules of origin. And lastly, there is little point in insisting on British standards. Exporters will obviously build products to the requirements of their biggest market — much like cars sold anywhere in the US comply with California’s emissions standards, because it would be more expensive to make separate models.

A precondition for this strategy would be for the UK to assume full responsibilities as a WTO member upon leaving the EU. Here, too, detractors have questioned the UK’s ability to fully extricate itself. In fact, the most legitimate position would be to adopt the current EU tariff schedule for goods on a most-favoured-nation basis and its commitments for services. For agricultural goods, it would be sensible to offer quotas equivalent to the UK’s current imports from non-EU countries, and to likewise adopt any existing EU tariffs as the UK tariff. This position will neither leave any WTO member state worse off in its trade with the EU nor discriminate against anyone. It is unlikely to be challenged successfully in the WTO dispute settlement system—and no matter what some Leave campaigners have asserted, the EU’s external tariffs are already among the world’s lowest in many cases.

In this scenario, the UK would surely lose some access to the EU market. Trade in financial services is unlikely to be as free as it is today. Even though 90 percent of additional demand in the next ten years is likely to come from outside of the EU, the EU without the UK will still be a fifth of the global economy. Constrained by global trade rules and voter expectations, the UK would be well served by coherent free trade agreement policy that starts with the EU, its most important partner.